nedsaid wrote:I see purchasing power as purchasing power whether it is dollars, pounds, euros, or yen. To me, currency diversification makes sense.

For all those in favor of currency diversification, can you answer my pension plan hypothetical posted above?

I already did. Was that in another thread, or did my answer get lost when the site went down? :/

I think you're thinking of another thread or else your response went into an IT black hole.

I really specifically remember answering it, so if you didn't cross-post, then it must have gotten lost when the site went down or something. Weird!

The gist of it was as follows, but I regret the longer version got lost:

Given the purely binary example you present (either 75% ex-US or 0% ex-US exposure), and assuming no other savings or assets, I would opt for the pension denominated in home-country currency. However, assuming this pension comes in addition to some savings, a house, social security, etc... I might well take the mixed basket. But if it's strictly a choice between being 75% ex-US or 0% ex-US, sure, I'll take the latter

The catch, of course, is that your hypothetical is really extreme ... in actual fact, even for someone holding 50% ex-US in equities at retirement age (say, 60, with age in bonds), their portfolio alone (NOT SS, house, etc...) only has 20% ex-US currency exposure. Add in other things and it starts dropping toward more like 10%. So, for instance, if you reframe the hypothetical and ask me whether I would rather have 100% US currency payouts or 90% US currency payouts, I would choose the latter. That last 10% might not do much in the face of global inflation, but it hedges fat tails I can't foresee better than 0% without adding much volatility.

"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

nedsaid wrote:I see purchasing power as purchasing power whether it is dollars, pounds, euros, or yen. To me, currency diversification makes sense.

For all those in favor of currency diversification, can you answer my pension plan hypothetical posted above?

One would be hard pressed to actually have such a pension scenario. But, I can offer a similar more realistic pension scenario. We’ll likely be receiving government/state pensions from 3 different countries from 3 different continents in 3 different currencies.

There are certainly some advantages:

- Minimizes regional risk- Minimizes country risk- Minimizes currency risk (in the sense that it maintains global purchasing power which means one could retire most anywhere)- Minimizes pension risk (three pension providers instead of one)- Potentially increases maximum pension available (due to a stepped approached paying the minimum into each pension system generally provides one a higher payout then putting it all into one system although this can be constrained by other issues such as residency, windfall elimination, means testing, etc.)

And some disadvantages:

- Spending the whole retirement period in just one of those three countries could see purchasing power in that country diminish if its currency consistently dominates. To some extent this may be offset based on the potential for a larger pension (see above). But, this can also be offset by home biases in one’s portfolio, annuities, and/or property assets (which is something you neglect as a possibility in your hypothetical)- Spousal survivorship rights may be more limited

Personally, I think the advantages outweigh the disadvantages but YMMV. And I would think that with such a setup the probability of having a significant loss is greatly diminished although the probability having minor losses increases.

At any rate, the bottom line becomes how much country risk one is really able to tolerate. This is one area where I think too many people but too much faith in outcome versus strategy. Of course, depending on which country you are from and how old you are this may bode well for you during your lifetime. But I might have another 40 years or more and my kids another 80 years. Country risk isn’t something I am quite ready to ignore.

tr123 wrote:What are the considerations when deciding what percentage of one's stock holdings to allocate to international stocks?

My thoughts (please correct me if I am wrong):Two reasons to invest internationally:- you diversify country risk to avoid significant underperformance.- you increase your opportunity set to earn good returns.

To choose an arbitrary fixed allocation ("30% international stocks") is neither an active nor a passive strategy. It is naive diversification IMO (which isn't necessarily bad).

An active investor picks country markets or international stocks like domestic stocks. (Currency risk is an input variable for both domestic and global investors) E.g.,:Bloomberg Video, David Herro (Oakmark Funds) on Stocks, Investment Strategy, March 28, 2013

Investors should place money where there is a return calling for it...if international stocks for some reason are more underpriced than domestic stocks than you should be more than 50% international. If they are about the same...maybe 30, 40, 50%...it all depends on relative valuations...

Another active investor could hope that the past predicts the optimal allocation.

We can think of two extreme and presumably unrelistic scenarios:

-If all investors invested globally and if market prices were set by global investors the 'representative investor' (and passive investors) would hold the global cap-weighted market portfolio.Country risk could disappear, correlations between country markets would tend to be high, and all stocks were priced versus global betas.

-If the market prices were set by domestic investors, country risk would be diversifiable and the correlation between country markets would tend to be low.You don't need to own all US stocks to diversify away the unsystematic risks of US stocks. And you wouldn't need to own all country markets to diversify away country risks (although it wouldn't be bad).A "passive" investor could copy the average asset allocation of all domestic global investors who have similar risk profiles.

That's the theory IMO. In practice, the differences may be unpredictable and the results may be similar.